October 7, 2021 Executive Compensation ESG & Human Capital Management QuickTakes

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ESG & Human Capital Management

Simple Rules for Including ESG In Incentives Beyond Materiality

The thinking around the incorporation of ESG in incentives has coalesced around the concept of materiality. There is general agreement that this means that the company should have the competencies and resources to make a material, positive impact on the ESG issue of concern.

But does it go beyond this? We think yes. First, the ESG improvement must provide a material benefit to a critical stakeholder or multiple stakeholders that the company sees as key to its future success. Will it provide significant benefit to the company’s current or potential customers, employees, suppliers, and/or society as a whole? Given limited resources, we think the company is best served by focusing on those stakeholders most proximate and from which future benefit might accrue.

Second, and related to the above, will long-term benefit accrue to the company? So, by benefiting stakeholder groups, will it, in turn, improve the company’s customer loyalty, increase employee engagement, strengthen the company’s supply chain, or help maintain its license to operate and thus benefit the company’s economics and shareholders over the long term? If not, the investment will likely not be sustainable from the company’s point of view. The key issue here is the potential timing disconnect. Even though the investment occurs now, the effect on stakeholders and the benefits to shareholders may not be evidenced until many years down the road.

Finally, will the benefits realized by society and shareholders exceed cost of the investment made on a time-adjusted basis? If not, the company should likely invest its ESG energies elsewhere.

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